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Wal-Mart's Margins May Bleed From Price Cuts

Heavy promotions in July could mean trouble for the retailer's earnings report Tuesday.
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SAN FRANCISCO -- Persistent price cutting likely will weigh on

Wal-Mart's

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gross margins when the world's biggest retailer reports its second-quarter earnings on Tuesday.

The Bentonville, Ark.-based company has backed its forecast for a profit of 75 cents to 79 cents a share for the second quarter, in line with analysts' average estimate of 76 cents and up from 72 cents a year earlier. But ongoing promotions -- amped up in July on more than 16,000 products -- will have their consequences.

"Customers are responding to the pricing initiatives and traffic trends are improving," said Eduardo Castro-Wright, Wal-Mart Stores U.S. president and chief executive, in a statement Thursday, when the company reported July sales. "However, this is impacting gross margins."

Wal-Mart posted a 1.9% increase in July same-store sales, or sales at stores open at least a year, beating analysts' estimates for a 1.5% rise. But the company noted ongoing weakness in its home furnishings and apparel categories, which is expected to show through in its earnings results.

Wal-Mart has attempted to change its apparel by making it more fashion-forward. But so far, it hasn't caught on with customers, at least not in the same way as at rival

Target

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, which has successfully kept up with the latest trends.

"Target has for a couple of dozen years been what you'd expect from a discounter coming out of a department store heritage," says Edward Weller, an analyst for ThinkEquity Partners.

Christine Augustine, an analyst for Bear Stearns, said she does not expect a meaningful pickup in Wal-Mart's apparel sales until the end of the third quarter.

"We believe inventory and clearance still have room for improvement," she wrote in a research note.

Sales in home furnishings, which have been hurt by a sluggish real estate market, remain slow, and Augustine said she does not anticipate improvement until the end of the fourth quarter.

For the second quarter, Augustine expects Wal-Mart to report a gross margin decline of 10 basis points because of the weak sales and increased markdowns in the apparel and home furnishings areas, which usually carry higher margins than other products.

"All in all, rollback levels throughout the store, at around 15,000-16,000, are significantly higher than the usual 10,000," she wrote. Augustine expects Wal-Mart to report earnings of 75 cents a share for the second quarter.

Groceries have been the company's saving grace, as have consumer electronics such as TVs and portable electronics. In the second quarter, it rolled out

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computers, giving it a boost in that category.